Fed says on track to support asset-backed market

LauraMandaro

SAN FRANCISCO (MarketWatch) -- The Federal Reserve is getting ready to launch a new program that should make it easier for consumers to get credit card and auto loans -- though not necessarily at lower interest rates.

The availability of loans would stem from reviving the moribund asset-backed securities market. The Fed reiterated its plans to start this program Wednesday afternoon, stressing the still "extremely tight" credit conditions for households and firms. Read more on the Fed.

The government appears to continue to demonstrate its commitment to efforts to jump-start the asset-backed securities market given its importance to consumer lending," said Kevin Duignan, head of U.S. ABS at Fitch Ratings.

In the last part of a three-pronged plan aimed at getting banks to lend more, the U.S. central bank next month will start offering up to $200 billion in loans to investors that hold AAA-rated securities backed by new consumer and small-business loans.

Three-part plan

The central bank unveiled TALF, short for Term Asset-Backed Securities Loan Facility, in late November after investors fled securitized debt.

Spreads on these pools of mortgages and credit-card loans had spiked in the wake of the September collapse of Lehman Bros., indicating a jump in costs for lenders of this debt.

'We're not sure the program is enough to get investors interested in buying asset-backed securities. It's not like the Fed is providing capital for the asset issuer.'
Sanjay Sakhrani, Keefe Bruyette &amp; Woods

From Libor minus 1 basis point before the credit crunch started, spreads zoomed to Libor plus 140 points at the start of September -- and then hit 575 basis points, the equivalent of fully 5.75 percentage points, at the start of December.

With risk fears high, new issuance plunged. If disruption of these markets went unaddressed, it could further choke off already tight consumer credit, the Fed said.

The first two programs aimed at mortgage-related securitizations have had some success. Mortgage rates hit historic lows earlier this month, and refinance volumes ballooned.

But the asset-backed program for credit cards faces a lot more uncertainty, investors say, because the Fed won't act as a buyer of last resort -- as it has with the mortgage-related debt.

Instead, it will encourage investors to use the Fed as a cheap bank by offering below-market loans to investors that can offer new asset-backed securities as collateral. There's no guarantee these investors will go along.

"We're not sure the program is enough to get investors interested in buying asset-backed securities. It's not like the Fed is providing capital for the asset issuer," said Sanjay Sakhrani, a stock analyst who follows credit card companies at Keefe Bruyette & Woods.

If investors do return to this market, issuance of new asset-backed securities will rise, indicating the originators of these loans can pool them and sell them to investors.

This offloading of loans into the secondary market would benefit big card companies such as J.P. Morgan Chase
JPM, -0.72%
Capital One Financial Corp.
COF, +0.87%
and Discover Financial Services
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When they can't securitize these loans, they hold them on their balance sheets and must allocate capital to support them. That's a cost.

Assets like "credit cards, autos and consumer loans -- the banks never held them on their books," said Ron D'Vari, chief executive at NewOak Capital, a New York firm that advises companies on investing in structured products.

"The cost of capital is so high, ultimately the borrowers have to bear that," he said.

Issuing more asset-backed deals, and thus gaining cheaper access to funding for their credit-card loans, could ultimately prompt these lenders to pass on lower costs to consumers by lending more freely -- say, by extending credit lines.

Still, analysts say even heavy appetite for new asset-backed deals may not result in lower rates for consumers.

"The question is, will they keep consumer rates high and use the excess net interest income to subsidize a lot of other losses, or will they lend it out," said Ed Grebeck, debt markets strategist for Tempus Advisors in Stamford, Conn.

Card companies are more likely to raise rates when credit card charge-offs and delinquencies rise -- regardless of their access to funding. That's a typical scenario when people start losing their jobs, as they're doing in droves. Read latest on job losses at Boeing. "This is going to be a tough year," said analyst Sakhrani. "We will have a big step upwards in the unemployment rate, and as that happens, it will have a big impact on credit quality."

FOMC thin on details

Analysts had hoped Wednesday's Federal Open Market Committee statement would yield details of this and other initiatives to support the credit markets by buying or guaranteeing bonds.

"To buy or not to buy is the question," said Ashraf Laidi, chief market strategist at CMC Markets, in emailed comments ahead of the meeting.

With its federal funds target rate near zero percent, the Fed's main ammunition is its balance sheet. It's been funneling cash into the credit markets by buying or guaranteeing illiquid securities. Read more on the Fed.

In the FOMC statement, the Fed reiterated that it may purchase longer term Treasurys if that would help private credit markets. It also said it could expand the first two parts of its three-part consumer lending program that are aimed at mortgage-related debt, "as conditions warrant."

But it gave no further details on TALF, the component that deals with bonds backed by credit-card and auto loans. Analysts had hoped the Fed might expand to include other shell-shocked credits, such as commercial mortgage-backed securities.

And they're looking for a firm start date. The Federal Reserve Bank of New York, which will administer the plan, has only said it will begin in February.

Fewer deals, fewer loans

Consumer credit hasn't collapsed since the asset-backed market closed shop. But it's a lot harder for consumers to get new loans or credit extensions.

Consumer debt fell $7.9 billion, or at a 3.7% annualized pace, to a seasonally adjusted $2.57 trillion in November, the most recent month for which the Fed has released data. That was the largest percentage decline in nearly 11 years.

During the same period, capital markets funding for about half of the credit card loans banks make dried up.

From Sept. 1 to Wednesday, U.S. lenders sold just $8.6 billion in asset-backed deals, according to Dealogic, or a mere 6.6% of the volume during the same period a year earlier. Four of the five deals issued since Dec. 1 have been from foreign automakers like Honda Motor Co.
HMC, +0.31%

The collapse of the asset-backed market has made issuers more hesitant to increase their credit lines. American Express Co.
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Capital One and Discover have "been actively managing their credit lines and slowed down growth. Their ability to fund has been restricted," said Sakhrani.

How it will work

The TALF is designed to encourage new issuance by allowing investors in AAA-rated ABS to provide those securities as collateral to the Fed in exchange for a loan of the same size, minus a "haircut," or discount. The Fed is expected to make these ABS-backed loans at favorable rates and limit the investor's losses.

Because investors can borrow cheaply to buy ABS, they are more likely to accept lower coupon rates on new issues.

"The idea is to generate investor demand for highly rated securities by allowing them to access cheap funds," said Glenn Boyd, head of U.S. asset-backed securities and commercial mortgage-backed securities strategy at Barclays Capital.

"At a minimum, it would help ensure continued access to credit for the consumer. If it really worked well, it could allow rates to drop."

Still, "at the moment, people are more concerned with preventing consumer rates from rising and access to credit."

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